Reflections on Taxes and Warren Buffett

This morning I was cruising through Byliner, my new favorite website, and I came across an article from Vanity Fair on Warren Buffett's view on the debt limit and marginal tax rate. I forwarded it to Jordan Needham, a Buffett aficionado, and asked what he thought about the tax rate.  His response was comprehensive and hit on numerous points I'd never considered.  While this deviates from the normal patter of posts I offer, I thought you'd enjoy his email as much as I did.

Yeah, [Buffett] was very critical of the Bush Tax Cuts:

His secretary is definitely paying in the 30% neighborhood. [Buffett's] is going to fluctuate much more because of the "mix" of income he talks about in the article. In that year, 2003, he is quoted as saying his rate is 30% and you found another place where he indicated 19%.

I definitely think those numbers are valid, or close to. Use Mr. Smith and Mr. Jones as an example.

Mr. Smith receives a bulk of his income from his law services. These will be substantial and will place him in margin bracket of 35%. Sure, he'll have some other investments - a few capital gains @ 15%, some dividend payments (hopefully qualified at @15%) - but the main driver of his tax return will be ordinary income at 35%.  

Mr. Jones on the other hand owns real estate which he typically holds for over 1 year. They (his group) do not typically charge fees, and when they do, they cover expenses. Again, he will have some other investments which will provide ordinary income to be taxed at higher rates, but by in large his tax return will be mainly 15% capital gain charges and a few ordinary income items.

Roughly - Smith pays ~30% and Jones pays ~20%.

Buffett is an especially unusual case because his net worth is tied up in a corporation. And not just any, but one that pays no dividend. Thus Buffett does not personally pay taxes each year on any of his $45 billion (or whatever the number is now) tied up in Berkshire. He is paid roughly ~$500,000 as CEO (largely due to personal security costs) and maybe another $100k for the different boards he is on. However, Buffett indicated that 98% of his net worth is in Berkshire, leaving $900 million elsewhere. Figure he earns 5% (I imagine he is pretty liquid), so $45 million @ 20% and $600k at 35% = ~20%.

Do I think the rich should pay more taxes, yes. Is that "fair," democratic, or equal? No. But it is more so than people believe.

Rich individuals are always going to be more able and more motivated to reduce their tax liabilities. A man making $50,000 a year would save $7,500 if his tax bracket was 20% instead of 35% (assume no stepped bracket system). Is that a lot of money? For him, yes - it could be a vacation, a supplement to his IRA, or a partial down payment. But he'll spend $X,000 on tax consultants, lobbyist, political contributions, etc. if you assume he has to pay in order to make it happen. A guy making $5,000,000/yr saves $750,000, and so his costs will be relatively minimal.

While the above is true, I think the real leveler is inflation. Inflation is the ultimate tax. With inflation at 5%, a dollar today buys $0.95 worth of goods next year, $0.86 in 3 yrs., $0.78 in 5 yrs., and $0.61 in 10 yrs. At 10% - 1: $0.90 5: $0.60 10: $0.40. The rich are paid each year through investments which typically have the ability to reprice their goods to inflation, pay interest rates that move with inflation, or they own inflation protected financial products (TIPS). Sure wages will rise with inflation, but slowly and unevenly. And I bet the average consumer is spending 80-90% of their income on expenses and thus he suffers a major lag to the individual turning savings into inflation-dampened assets.

The comparison is not apple-to-apples. Taxes are a percentage, cost of living is a number.

Simply put the rich can handle it. While that sounds like socialism - which it does - it is not. "Handle it" should be replaced with "plan for it." The rich can and do position themselves to survive, the poor do not or cannot. Darwin may have given the conclusion to that paradigm, but the rich are only stronger so long as the poor allow them to be. Revolution is born out of poverty (France 1792). It ultimately will not serve the rich.